Wednesday, February 8, 2017

The earnings recession is over - that is a good thing!

From the Desk of Joe Rollins

Every quarter for the last three years, all anyone can talk about when valuing the stock market is how the overall earnings of the Standard and Poor’s Index of 500 Stocks have gone down. This is principally because the earnings of the oil companies have pretty much been a disaster since the price of oil has now fallen roughly 50% (and 75% last summer). These oil companies represent a large component of the S&P earnings and have dragged down the other companies. But hold onto your seats – the earnings for the fourth quarter of 2016 are now pretty much assured to be up 8-9%. Not only is this a net positive increase of earnings, it is a dramatic increase. In addition, every quarter in 2017 is now forecasted to be higher, percentage wise, than a comparable quarter in 2016. As I have predicted over the years in my blog postings, nothing impacts the stock market more positively and more convincingly than an increase in earnings. I have a lot to discuss in this blog since the news has been coming fast and furious since the inauguration of President Trump, but first I want to reflect on how good the month of January actually was.

There is an old saying on Wall Street, “As goes January, so goes the year.” If that actually proves to be true, then 2017 could be a sterling investment year for us all. For the month of January, the S&P 500 Index was up 1.9% and over the one-year period up 20%. The NASDAQ Composite had a sterling month of 4.4% and for the one-year period is up 23.2%. The Dow Jones was up a laggard 0.6% but still up 23.9% for the one-year period. Of course, the laggard as you would expect with interest rates increasing would be the bond index. The Barclays Aggregate Bond Index was up 0.2% for the month of January and 1.2% for the one-year period. If you have a high concentration in bonds in your current portfolio, there is a high likelihood that you will be disappointed with your investment results this year. It is almost a “slam dunk” that the Federal Reserve will increase interest rates at least twice, probably three times, in 2017. They have the cover to dramatically increase rates without dragging down the economy. I think it is a given that we will see rate increases periodically during 2017, which will adversely impact bonds.

Harper, Ava, Lucy & Caroline at the Grand Ole Opry

Swimming in January!

Studying the stock market with CiCi

Before I write my commentary, I want to make sure that everyone understands that I really do not care about politics. What I do care about deeply though is the affect that politics has on the economy. To the extent that actions by Congress affect the economy, I have the utmost interest. Therefore, my reflections below are more concerned about the politics of the economy, not the politics of popularity.

If you are not excited about the economy with all that newly elected Trump has done in the last three weeks, perhaps you do not know how to read The Financial Tea Leaves. Yes, I understand it has been volatile and confusing. Sometimes the tweets get more attention than the underlying policies, but the policies have been dynamic and each are designed to improve the economy. Already, in just this short time period, the President has implemented the following:

1. A slowing down of Obamacare, which was a drag on business and a regulation nightmare.
2. Authorization of the Dakota Access and Keystone XL pipelines. Both of these pipelines work towards bringing the U.S. closer to energy independence and create multi-thousands of high-paying jobs in construction, which are high paying and extraordinarily beneficial to Americans. In addition, all of the steel pipe will be built in America, which is helping an industry that has clearly suffered over the last decade.
3. Proposed executive order that regulations by the government be dramatically reduced, getting government out of private businesses. The new executive order requires that for every new regulation, two must be deleted. This is nothing but positive for the economy and all Americans working in the U.S.
4. Proposed border tax, which will create more jobs in America. The car companies will be hard pressed to build manufacturing plants in Mexico if a tax is attributable to any car sold in America. For all of you who are really worried about trade war, that is a worry you can forget. The United States is the strongest and most powerful economy in the world. Everyone wants to sell in the United States. They need us more than we need them. Already, we have seen the largest manufacturer of Apple iPhones in China has already committed to building a plant in the U.S. European car companies are now scrambling to relocate the production of cars from Europe to the U.S. Even though absolutely nothing has happened, more jobs have been created and promised in three weeks in the U.S. than we have had in the last decade.
5. A commitment to repatriate $1-$2 trillion in foreign money to the U.S. with preferred tax rates. If you needed to point to one thing that would create jobs and wealth in America, this is it. It is almost more embarrassing that the U.S. corporations parked $2 trillion in cash overseas just because they are afraid of taxation in the United States. We need that money back in this country to create more wealth.
6. Proposed a tax decrease for both corporations and individuals that will dramatically increase the economy, create more jobs, and the item that we are most interested in, build wealth. I know most of you are not as old as I am, but if you go back and look at the U.S. economy under Ronald Reagan beginning in 1980 through 1988, you will see the dramatic increase in the economy that lower tax rates can create. Those of you who are concerned that these lower tax rates will create deficits have not been watching very closely over the last eight years. Despite having the highest tax rate we have ever had in the United States, the national debt in the United States went up $9 trillion during the Obama administration. You do not need to be a rocket scientist to understand that higher income tax rates are detrimental to the economy and therefore create more deficits than lower tax rates. John F. Kennedy proved this in the 1960s, Ronald Reagan proved it in 1980 and I am absolutely convinced lower tax rates under President Trump will improve the economy and reduce deficits, not increase them.

I am an avid reader of Barron’s which comes out every week. The lead article on the cover of Barron’s last week was Next Stop, Dow 30,000. Basically, the article indicates that the Dow should be at 30,000 by the year 2025. Given that it is roughly 20,000 now, what does that really mean as it increases over the period from 2017 through 2025? While on paper this sounds like a dramatic increase annually to go from 20,000 to 30,000 in the next nine years, if you do the math, the increase is a relatively modest 4.6%. If you will review the blog that I posted on January 3, 2017, you will note that over the last 14 years, the S&P 500 has been up an impressive 9.12% on an annualized basis, and this includes 2008, when the S&P was down 37%. So, to project 4.6% growth over the next nine years, I think, by most people’s definition, would truly be quite modest. If you increase that gain to a more normalized 7%, the Dow would be closer to 37,000, not 30,000. We have a unique opportunity to build wealth over this next decade, yet there are so many people underinvested who will not get to participate in that wealth.

For many years, I have been advising clients to contribute annually to an IRA, whether it is deductible or not. If you qualify for a Roth, you should beg, borrow or steal in order to participate. You should never pass up on an opportunity to put money away on a tax-exempt basis for the rest of your life, and for the life of your beneficiaries. However, despite begging clients to contribute many still will not listen. I hope you understand the benefits of investing on a regular basis and take advantage of IRAs for this year and last year, as well as every year going forward.

Economically, it is impressive how much has been accomplished in only three weeks. I guess for every negative one can point out, I can illustrate multiple positives. It now looks like the S&P earnings with the proposed tax cut could jump up to as much as $142 this year. That is a dramatic increase in earnings, which will result in higher stock prices. While the “doomsdayers” have insisted the increase in the dollar would dramatically hurt U.S. earnings, this just has not been proven to be correct. The dollar has risen 25% since July 2014, due to higher interest rates in the United States and a weakened euro. However, it is interesting to note that with a 25% increase in the dollar, earnings have not been affected that much. People do not fully understand how sophisticated big corporations are in hedging currencies and avoiding big swings in the dollar.

The other exciting economic revelation is the dramatic decrease in regulations for banks. Ever since 2008, banks have been stifled in their opportunity to help the U.S. economy. Yes, I understand that 2008 was a dramatic shock to the world economy, but as congress does with virtually everything they touch, they overregulated it. By implementation of a hodgepodge, unorganized and uncoordinated regulation avalanche, banks have been much better served by holding their money rather than lending it. If banks got back to a normal lending environment, you would see the economy benefit dramatically. I will give you a personal example to point out how completely inane the current regulations are. Just recently, we had a client who was interested in purchasing a home and had enough cash for the house, three times over. Since she wanted to build up her credit and utilize her cash for investing, we attempted to finance a small portion of the house with a local lender. Despite her significant wealth, substantial assets and ability to pay cash for the house, she was unable to obtain a home mortgage loan. I will not go into further detail about how upside down these current regulations really are, but it does look like they will be significantly reduced.

I watch earnings closely, as do most people who invest in the stock market, and if you are not blown away by the earnings in the technology sector, you must not be watching closely. Companies such as Microsoft, Alphabet, Facebook and Apple recently posted earnings that are nothing short of extraordinary. These companies essentially create software and communicate with the world. While there is some manufacturing involved with Apple and Microsoft, their real business is technology. These earnings have increased dramatically year over year, and the projections for the current year are even higher. This increase in technology will prevent any trade war with the United States, since it can be exported around the world by the push of a button. The U.S. controls software that drives computers throughout the world and that is not going to change. No other country has the capacity, ability or innovative technology that would rival the software in the United States. Any trade war with the United States would clearly include software, and no country in the world could risk not having the U.S’s software capabilities.

As you can tell from above, I feel good about what has occurred in the economy in the last three weeks. In fact, I have not been this excited about the economy in years. Who would have thought that in three weeks we could solve major problems and free the economy to produce at a high level? I think we will see major manufacturing around the world come to the United States to avoid trade duties. They can produce just as well in the United States and avoid huge transportation costs. You will see not only Europe manufacturing in the U.S. but also China, Japan and Southeast Asia. All of this will be positive for the U.S. economy and in turn, good for the stock market.

On a side note, I was watching a special on HBO this past weekend regarding Warren Buffett. Buffett, who is probably the second or third richest man in the world, admitted that he never spends more than $3.17 on breakfast, and has no computer or telephone on his desk. But the item that really got my attention was when he commented on his health. He said that he checked the actuarial tables and found that six year olds have the lowest death rate and, therefore, eats like one. The most alarming aspect of his diet is that he drinks at least 5 Coca-Cola’s per day – and not the diet kind. Considering he is 86 years old, he might be onto something. Perhaps I will revert back to the diet of a six-year-old as well…

As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

Best Regards,
Joe Rollins